Financial Times: Low Mortgage Rates under Real Threat

People have been predicting that mortgage rates would inevitably rise ever since they first fell below 6 percent in April 2008. But on May 28, 2013, The Financial Times (FT) warned of an imminent event that "threatens to raise borrowing costs for American homebuyers".

Low Mortgage Rates and the Fed

So what is this threat? Here's a bit of background:

When you borrow money to buy a home, the company that lends to you rarely keeps the loan on its own books. Instead, it sells the debt on to investors around the world in the form of mortgage-backed securities (MBS). Before the credit crunch, these were packaged into bundles called collateralized debt obligations (CDOs), assessed for risk -- often wrongly back then -- by credit reference agencies, and then put on the global market.

Unsurprisingly, private investors were seriously spooked by the credit crunch, and wanted nothing more to do with MBS. So the Federal Reserve started buying them, and charged very low -- arguably, artificially low -- interest rates. So it's the Fed that's largely to thank for the recent availability of the best mortgage rates in history.

The causes of the FT's warning are recent indications of a shift in the Fed's policy on mortgage-backed securities, contained in the minutes of its latest Federal Open Market Committee meeting, published May 22. It may soon -- maybe in June or possibly September, depending on whom you believe -- begin to reduce its purchases of these securities. Given that it is currently buying MBS at a rate of about $40 billion a month, that could have a significant and fairly rapid impact on current home mortgage rates.

A Gentle Rise in Mortgage Rates?

Of course, the last thing the Fed wants to do is undermine the housing market. On the same day the FT's story appeared, The New York Times described rises in real estate prices as "driving the economy," and linked them to improvements in both consumer confidence and spending.

You can see why. The Times was reporting the latest figures from the S&P/Case-Shiller Home Price Indices, which were also published on May 28. These showed that nationally, home prices rose 10.2 percent in the 12 months ending March 31. That's the best rate of increase seen since 2006-07, and better than the whole period since 1988, except for the few years leading up to the bursting of the housing bubble.

Housing Market Recovery Still Fragile

However, it's still too soon to see the real-estate recovery as firmly established. David M. Blitzer, chairman of the Index Committee at S&P Dow Jones Indices, commented in a statement:

"... the larger than usual share of multi-family housing, a large number of homes still in some stage of foreclosure and buying-to-rent by investors suggest that the housing recovery is not complete."

So the Fed faces a difficult challenge: It needs to withdraw from the home-loan market in a way that doesn't send today's low mortgage rates shooting up so fast that demand for housing is reduced. In theory, it has the tools and skills to achieve that, but in practice things may turn out differently.

What This Might Mean for Consumers

If you've been biding your time, waiting for the right moment to buy a home or refinance your mortgage, you might at this point be hoping for some definitive advice. Sadly, no market -- including those for mortgages and homes -- is made that way.

There are simply too many factors that nobody can predict. If unemployment rates rise over the coming months, the Fed might change its mind about withdrawing from the MBS market. And, as the Wharton School of the University of Pennsylvania recently noted, private investors are regaining their appetite for collateralized debt obligations, which might just mean that a gradual withdrawal by the Fed could result in only relatively small increases in mortgage rates.

Low Mortgage Rates Predicted to End

Right now -- and before the Fed's recent signals have had time to sink in -- few experts are predicting sharp increases in rates, although many are forecasting an overall upward trend in the coming months and years. For example, the Mortgage Bankers Association expects 30-year fixed mortgage rates to average 4.4 percent next year, compared to the 3.59 percent that Freddie Mac reported for weekending May 23.

Using LendingTree's mortgage payment calculator, you can see that such a rise would result in a monthly payment on a $200,000 mortgage increasing from $908 to $1,002. Multiply that $94 difference by the 360 payments you'd expect to make on a 30-year home loan, and you're looking at more than $33,800.

But the fact is, nobody knows for sure how high or low mortgage rates could be next year. What those who choose to buy or refinance now know for sure can be summed up in a May 23 statement from Freddie Mac chief economist Frank Nothaft: " Fixed-rates moved up for the third consecutive week... [they] are nonetheless low and home-buyer affordability high." Those who choose to wait must be sure they're comfortable with a more risky future.